How much income tax you owe is depends on two things: 1) how much taxable income you have and 2) the tax rate applied to that income.

Taxes = Taxable Income x Tax Rate

Last month, I showed you how the new tax law will impact the calculation of your taxable income, as a result of numerous changes to deductions, exemptions, etc. But that is only half of the equation: we also have to look at the tax rates applied to that income. That's why this month, we're talking about those tax rates, most of which were reduced by the Tax Cuts and Jobs Act of 2018.

For most of us, the formula above is an oversimplification because we don't have just one tax rate. The United States has a progressive tax system. Progressive means that, as your income goes up, the rate of tax you pay also goes up. But you only pay the higher tax rate on the additional income, not all of it, so that higher rate is called your marginal tax rate because you pay that rate only on the highest portion of your income.

The graphic at the top of this post illustrates how marginal tax brackets work. Taxable income amounts for single filers are on the left side, and married filing jointly incomes are on the right. When your income fills up the first bucket, the additional income flows into the next bucket and gets taxed at the higher rate. So someone with a high income would have income in the lavender bucket taxed at 10%, income in the blue bucket taxed at 12%, income in the green bucket taxed as 22%, and so on.

Now look at the chart below, for single filers. Consider the example of Josie, a single woman with no children and who does not own a home. She earns $57,000 in 2018. She will subtract the new standard deduction amount of $12,000, plus $1000 for student loan interest. (For a comparison of these items under the old and new tax law, see last month's post.) That leaves her with $44,000 of taxable income. The first $9525 will be taxed at 10%. The next $29,175 of her income – the income between $9525 and $38,700 – will be taxed at 12%. And the last $5300 of her income – the amount over $38,700 – will be taxed at 22%. Her total tax will be $5620. Her marginal tax bracket is 22%, but she only paid that rate on the last $5300 of her income, not the entire $44,000.

Single filer

Income

Josie's income

2018 tax rate

Tax owed on that portion of your income

$0 to $9,525

$9,525

X

10%

=

$953

Over $9,525 but not over $38,700

$29,175

X

12%

=

$3,501

Over $38,700 but not over $82,500

$5,300

X

22%

=

$1,166

Over $82,500 but not over $157,500

-

X

24%

=

-

Over $157,500 but not over $200,000

-

X

32%

=

-

Over $200,000 but not over $500,000

-

X

35%

=

-

Over $500,000

-

X

37%

=

-

Total

$44,000

$5,620

Let's look at how much tax Josie might have paid in 2017 -under the old law – if her income and situation was the same.

Most of the 2017 tax rates were higher than the new rates for 2018 except for the 10% and 35% brackets. But the amount of income covered by each bracket has changed, too.

To determine how much tax Josie would have owed under the old rules, we first have to calculate her taxable income. From her $57,000 of income, she would subtract a standard deduction of $6350 plus an exemption of $4050, and her student loan interest deduction of $1000. That gives her taxable income of $45,600 – a little more than under the new law. That extra taxable income, plus the higher tax rates for 2017, mean that the new tax law saved Josie $1,360.

Single filer

Income

Josie's income

2017 tax rate

Tax owed on that portion of your income

$0 to $9,525

$9,525

X

10%

=

$953

Over $9,525 but not over $37,950

$28,425

X

15%

=

$4,264

Over $37,950 but not over $91,900

$7,050

X

25%

=

$1,763

Over $91,900 but not over $191,650

-

X

28%

=

-

Over $191,650 but not over $416,700

-

X

33%

=

-

Over $416,700 but not over $418,400

-

X

35%

=

-

Over $418,401

-

X

39.6%

=

-

Total

$45,000

$6980

Now you can see why it's so difficult to say who will pay less income tax and who will pay more under the new tax law. It all depends on the details: how you are affected by all of the individual changes I discussed last month, plus where your income falls in the new tax brackets.

Since this post is already lengthy, I will postpone talking about a few more aspects of the tax bill until next month. If you have questions about changes to the kiddie tax, ABLE accounts, estate and gift tax, recharacterizing IRA contributions, 529 plans, and how inflation will be calculated in the future, please check back around March 22.

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